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Relying on the agent in charge of production for project evaluation

  • Doh Shin Jeon

I study the optimal project choice when the principal relies on the agent in charge of production for project evaluation. The principal has to choose between a safe project generating a fixed revenue and a risky project generating an uncertain revenue. The agent has private information about the production cost under each project but also about the signal regarding the profitability of the risky project. If the signal favoring the adoption of the risky project is goods news to the agent, integrating production and project evaluation tasks does not generate any loss compared to the benchmark in which the principal herself receives the signal. By contrast, if it is bad news, task integration creates an endogenous reservation utility which is type-dependent and thereby generates countervailing incentives, which can make a bias toward either project optimal. Our results can offer an explanation for why good firms can go bad and a rationale for the separation of day-to-day operating decisions from long-term strategic decisions stressed by Williamson.

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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 623.

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Date of revision: Jan 2006
Handle: RePEc:upf:upfgen:623
Contact details of provider: Web page: http://www.econ.upf.edu/

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